The Positive Implications Of Foreign Aid And Economic Growth

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CHAPTER ONE: INTRODUCTION 1.1 Background to the Study The role of foreign aid in the growth process of developing countries has been an issue of intense debate. Foreign aid is an important issue given its implications for poverty reduction in developing countries. Previous empirical studies on foreign aid and economic growth generate mixed results. For example, Addison, Mavrotas and McGillivray (2005) find evidence for positive impact of foreign aid on growth; Abegaz (2005) find evidence for negative impact of foreign aid on growth, while AFDB (2005),AFDB (2004) find evidence to suggest that foreign aid has no impact on growth. It should be noted that, although Adelman (2000) concluded that foreign aid has positive effects, this conclusion applies only to economies in which it is combined with good fiscal, monetary, and trade policies. The main role of foreign aid in stimulating economic growth is to supplement domestic sources of finance such as savings, thus increasing the amount of investment and capital stock. As Adelman (2000) points out, there are a number of mechanisms through which aid can contribute to economic growth, including (a) aid increases investment, in physical and human capital; (b) aid increases the capacity to import capital goods or technology; (c) aid does not have indirect effects that reduce investment or savings rates; and aid is associated with technology transfer that increases the productivity of capital and promote endogenous technical change.

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